Insider Buying at NuStar Energy: Buy Signal for Investors?

On May 10, 2011 and May 11, 2011, William Greehey, a director at NuStar Energy L.P. (NYSE: NS), purchased a total of 76,000 common units at an average price of about $63.62 per common unit. (You can check out the Form 4 filing that contains this information on the SEC's website.) Should average investors take this as a "buy signal" and purchase NuStar common units?

As I've written about in a previous post, the returns achieved by company "insiders" (i.e., the executive officers and members of the company's board of directors) when such insiders trade in their own company's stock are often higher than the returns of the market as a whole. The securities laws in this country require that insiders report all transactions they make, including buying or selling shares of their company's stock in the open market, to the Securities and Exchange Commission within two business days of each transaction, and this information is publicly available, free of charge, for anyone to review. These reports (called "Form 4s") provide a treasure trove of information about what the insider thinks about the value of his company's stock. What's more, these reports allow regular investors like you and me to mirror the trades made by company insiders.

The implications of this information to the average investor are huge. Just think about it for a second -- if you, an average investor, were able to mirror the insider's trades at basically the same price as the price the insider paid, you would stand a very good chance of outperforming the market, too.

Interestingly, though, not all insiders are equally gifted in beating the market. Just as some money managers seem to have a better knack for timing the market, so, too, do some company insiders.

Let's take a look at all of the purchases and sales by Mr. Greehey (the insider who purchased a total of 76,000 NuStar common units last week) in NuStar to get a general sense for this insider's ability to favorably time his purchases of NuStar.


Sources: Stock price data comes from Yahoo! Finance, while data on open market purchases comes from the SEC's website.

The chart above shows NuStar's unit price from January 2002 until May 13, 2011. The red dots indicate times when this particular NuStar insider made open market purchases. (Note that this insider has never made an open market sale of any common units he holds in NuStar, which is likely an indication of his bullish view on the long-term prospects for NuStar.) The first thing I notice in the chart above is that this insider has purchased common units during each of the three major "troughs" in the chart above. He purchased around April 2003, again in February and May 2006, and he also scooped up some common units in July and October 2008. Each of these purchases turned out to be a great investment decision.

It is also apparent that this insider's timing is far from perfect. Because he is restricted by securities laws and his own company's trading policies from trading on material non-public information, this is to be expected (no one has perfect timing, not even insiders). For instance, a series of purchases in early 2007 now appear, with hindsight, to have been a poor investment decision. Furthermore, the insider appears to have pulled the trigger on a series of purchases in November 2007 and January 2008 a bit too early.

On the whole, though, this insider's open market purchases appear to be fairly well-timed given a long enough holding period -- at least based on the chart. However, the chart can only give us a general sense for whether an insider's trades are worth mirroring. To truly gauge an insider's trading performance, we need to compare the gains made by NuStar for each trade shown above with the gains of a comparable index. In this case, the index against which we should measure the insider's performance is the Alerian MLP Index. (For those unfamiliar with the Alerian index, it is an index comprised of 50 of the largest master limited partnerships, or MLPs for short.)

The chart below shows the average total return (including both price appreciation and distributions) over the six month, one year, and two year periods following each of the insider's open market purchases that would have been achieved by an investor who mirrored each of this insider's trades.


Sources: Yahoo! Finance, SEC filings, and author's calcuations.

In the chart above, the insider's outperformance (or underperformance) relative to the MLP index for each holding period is shown by the green bar. As you can see, this particular insider's purchases have, on average, actually underperformed the MLP index over the six month and one year periods following the purchase. Put another way, if you had mirrored each of the insider's previous trades and then sold your holdings six months or one year after the date you made your purchase, you would, on average, have underperformed the MLP index. However, when the holding period is bumped out to two years, the insider actually outperforms the MLP index by more than 5% of total return.

What causes this insider to be able to outperform over long periods of time but underperform for shorter periods of time? I would speculate that there are two primary causes for such long-term outperformance. First, this insider likely takes a very long-term view when deciding whether to purchase NuStar's common units, a decision that is likely not impacted by potential short-term price swings. Based on the fact that this particular insider has not sold any common units on the open market since at least 2003, this insider has demonstrated that he clearly considers NuStar's prospects going forward several years or more into the future (and likely well beyond the two year holding period evaluated in the chart above). Furthermore, because insiders are generally required by law to hold any securities purchased on the open market for a minimum of six months, this insider, much like Warren Buffet and other long-term investors, is likely not bothered by short- and medium-term swings in the price of NuStar common units, because the insider had no intention of selling them during that time period regardless of the price.

Second, I believe that the short-term underperformance could be in part due to a quick trigger finger on the part of the insider. Though virtually no one buys at the absolute bottom, it does appear on several occasions that, had the insider waited for the price to decline further before making a purchase, he could have significantly increased his return over the six month and one year periods. There could be many reasons for pulling the trigger early, including black-out periods or other restrictions imposed by law or by NuStar's insider trading policy.

Conclusion
By examining an insider's past trading history, we can get a very good sense for that insider's thought process regarding future trades. In this particular case, I am taking away two lessons regarding Mr. Greehey's open market purchases and how such purchases should be interpreted for maximum gain. First, this insider has a proven history of long-term outperformance, and mirroring this insider's trades is probably a good idea for someone who intends to hold the common units for two years or more. Second, this insider is sometimes "early to the dance" and often buys before the price has bottomed, which could account for some of his short-term underperformance. Perhaps some or all of this underperformance could be avoided by an average investor who is mirroring Mr. Greehey's trades by waiting for a pullback in price to a level that is below what this insider paid.

In the interest of full disclosure, I purchased more NuStar common units on Friday. I saw that the insider made large open market purchases on May 10th and 11th and saw the price of the common units dip below the price the insider paid (the insider paid between $63 and $64, but the common units closed on Friday at $61.89).

Disclosure: I am long NS.